MONTECILLO, IVORY MAE D.

BSBA FM 2-1

POLYTECHNIC UNIVERSITY OF THE PHILIPPINES

SAN JUAN BRANCH

Review Questions on Financial Management (FIMA 30013)

Midterm Period

Lesson 1: Introduction to Financial Management

a. What is finance? Explain how this field affects all the activities in which businesses
engage.

Finance is an art and science of managing money, that deals with the process
institutions, markets, and instruments involved in the transfer of money among
individuals, businesses, and governments. This also empowers people to make better
financial decisions. This field is the main source which the company is working it is like
the veins of the company and the money, investments being the blood that runs through
the veins supplying all the organs which are the different departments of the company
that is why it affects all the business engagements. Every move the company will take,
there is always a financial obligation.

b. What is the financial services area of finance? Describe the field of managerial finance.

Financial services are concerned with the delivery of advice with regard to
financial products to individuals, businesses, and governments. Involving a variety of
career opportunities in the field of banking, personal financial planning, real estate,
investment, and insurance. The field of Managerial finance is focused on the duties and
responsibilities of a financial manager who works in a business firm. Financial managers
are concerned with all types of financial affairs in all types of business.

c. Which legal form of business organization is most common? Which form is dominant in
terms of business revenues?

The most common legal form of business is sole proprietorship because it is the
easiest way to establish a business because it is only owned and operated by one
person. Which indicates a low organizational cost, higher tax savings, ease of
dissolution, and with its independence and secrecy the owner receives all the profit. And
the most dominant in terms of business revenues are the corporations due to their
capacity to invest more and take higher risks so when the returns have come it will make
a big impact on revenues.

d. Describe the roles and the basic relationships among the major parties in a corporation –
stockholders, board of directors, and manager. How are corporate owners rewarded for
the risks they take?

The owners of a corporation are called stockholders whose ownership takes from
either common stock or preferred stock. Corporate owners are the one who takes the
risk with regards on investing because they are the life source of the company. Having
the risk of investing they are rewarded through dividends or residual claimants. The
Board of Directors is the people who have given the power of responsibility by the
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BSBA FM 2-1

stockholders in a voting manner. These people are responsible for setting general
policies, approving strategic goals and plans, approving major expenditures, and guiding
corporate affairs. In addition, managers are the one who is responsible for managing
day-to-day operations and carrying out the policies established by the board of directors.
They are the people who maximize the capital that was invested by the stockholders.

e. Why is the study of financial management important to your professional life regardless
of the specific area of responsibility you may have within the business firm? Why is it
important to your personal life?

The importance of financial management in our professional life regardless of the

specific area of responsibility is that it serves as the guide within the business. Because
everything we do within the company has a financial consequence. Considering the
main goal of every business firm is to maximize the capital invested by the owners.
Without an understanding of financial management is more likely that the company will
fail.

Regarding my personal life, for me it is the most essential and the most important
thing to know, it is the know-how on managing personal finances. This will serve as the
guide for me to be able to budget all the income I am gaining and how to spend it wiser.
In short, financial management in my personal life guarantees the most possible comfort
I can have.

Lesson 2: Financial Markets, Institutions, and Interest Rates

a. Who are the key participants in the transactions of financial institutions? Who are net
suppliers, and who are net demanders?

The key customers of financial institutions are individuals, businesses, and the
government. Individuals who are basically net suppliers because they save more than
they borrow, the savings that individual consumer becomes the finds used by the
financial institutions to lend to the government and business firms. While businesses
seek funds borrowing to the financial institutions, they also save in checking accounts in
various commercial banks. Governments do not borrow funds directly from financial
institutions, but they do sell debt securities to various institutions. Business firms and
governments are net demanders because they borrow more than they save.

b. What roles do financial markets play in our economy? What are the primary and
secondary markets? What relationship exists between financial institutions and financial
markets?

Financial markets are a type of marketplace that provides a place for the sale
and purchase of assets such as bonds, stocks, foreign exchange, and derivatives.
Financial markets play a vital role in our economy, they provide a place where
participants such as investors and lenders behave appropriately and appropriately
regardless of their size. They provide access to capital for individuals, companies, and
government agencies. Financial markets help reduce unemployment because they offer
so many job opportunities.

The primary market is involved in direct transactions offered by the corporate or

government and takes direct advantage of the problem. That is, the company earns
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BSBA FM 2-1

revenue from the sale of securities. Once securities start trading between savers and
investors, they become part of the secondary market. A primary market is a place where
new securities were sold, and a secondary market can be viewed as a pre-owned
security market.
Financial markets make it easier for people who invest money in capital investments to
move money by saving money. Financial institutions distribute and improve funds,
money, and capital in a few ways: Payment method. Securities Trading. Therefore,
financial markets and financial institutions are interdependable with each other.

c. What is the term structure of interest rates, and how is it related to the yield curve?

The term structure of interest rates shows the relationship between interest rates
and different maturities. The time to maturity is the length of the holding period of the
bond while the yield to maturity is the expected return of the bond. This relationship
when graphed is called a yield curve. A yield curve shows the pattern of annual returns
on debts of equal and different maturities.

d. For a given class of similar-risk securities, what does each of the following yield curves
reflect about interest rates: (a) downward-sloping; (b) upward-sloping; and (c) flat? What
is the normal shape of the yield curve?

A downward-sloping yield curve is an inverted yield curve or a negative yield

curve. This curve is relatively rare when market confidence drops people will seek more
secure long-term investments. Thus, this curve pertains to a lower long-term interest
rate. Some of the professionals say that this is a warning of an impending recession.

An upward-sloping yield curve is a nominal yield curve or a positive yield curve.

This is what you can mostly see in each economy that is why it was called normal
because the market usually expects more compensation for greater risk. In this kind of
curve long-term interest rates is greater than short-term interest rates.

A flat yield curve is when short-term and long-term bonds see no visible change
in rates. These give a similar rate for both long-term and short-term interest, this only
happens in a perfectly balanced economy.

e. Briefly describe the following theories of the general shape of the yield curve: (a)
expectations theory; (b) liquidity preference theory; and (c) market segmentation theory.

Expectations theory has a strong relationship between inflation and interest

rates. Inflation and interest rate are directly proportional. If there is an expectation of
higher future inflation equals higher interest rates on the long-term bond that will give a
normal yield curve. On the other hand, if the expectation is lower future inflation it only
means lower interest rates on the long-term bond pertaining to an inverted yield curve.

In the Liquidity preference theory, investors think that long-term bonds are riskier
than short-term bonds. They have less liquidity when money is tied up for a longer
period and demands higher interest rates to compensate for the level of risk. This theory
shows a positive yield curve because long-term rates are greater than the short-term
interest rates
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BSBA FM 2-1

Market Segmentation theory concludes that long-term interest rates and short-
term interest rates do not have a relationship with each other. States that short-term
bonds and long-term bonds should be viewed separately. If the demand is greater than
the supply for the short-term funds, there will be a high-interest rate that will give an
inverted yield curve. But if the demand is lesser than the supply of short-term funds,
there will be a lower interest rate giving a normal yield curve. Therefore, the demand and
interest rates are directly proportional.

Lesson 3: Financial Reporting and Analysis

a. What roles do the Generally Accepted Accounting Principles (GAAP) and the Financial
Accounting Standards Board (FASB) play in the financial activities of public companies?

Generally Accepted Accounting Principles (GAAP) are practice and procedure

guidelines used to prepare and maintain financial records and reports. On the other
hand, the Financial Accounting Standards Board (FASB) is an accounting profession’s
rule-setting body, which authorizes generally accepted accounting principles (GAAP).
Both serve as the regulator and moderator of the firms as they provide guidelines that
are used to keep financial records transparent.

b. Describe the purpose of each of the four major financial statements.

The four key financial statements are (1) Statement of Comprehensive Income or
Income Statement. This provides a financial summary of the firm’s operating results
during a period that shows net income or a net loss. This type of statement tracks all the
money coming in or the revenues and all the money going out or the expenses. And
include the earnings per share and dividends per share. (2) Statement of Financial
Position or balance sheet. This is a summary of the firm’s financial position, showing the
company’s assets, liabilities, and shareholders’ equity at the end of the reporting period.
(3) Statement of Retained Earnings or Statement of Stockholder’s Equity. This shows
the additions and subtractions for a particular period and that include things like net
income, dividend payments, and withdrawals. (4) Statement of Cash flows summarizes
an entity's cash receipts and cash payments relating to its operating, investing, and
financing activities during a particular period.

c. Why are the notes to the financial statements important to professional securities
analysis?

Notes to financial statements are footnotes detailing information on the

accounting policies, procedures, calculations, and transactions underlying entries in the
financial statement. These notes are important because these statements show the
breakdown of financial activities that can explain the know-about in each item in the
statements.

d. Regarding financial ratio analysis, how do the viewpoints held by the firm’s present and
prospective shareholders, creditors, and management differ?

The viewpoints differ with regard to their role in the firm. Present and prospective
shareholders’ role is to invest money with this focusing on the profitability measures and
market ratios because it indicates the level of risks when pursuing an additional
investment. While investors are concerned with the liquidity measures of the firm so they
will be able to predict if the firm can pay or not in the future. Moreover, the manager’s
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BSBA FM 2-1

viewpoint is broader than the two entities. They are concerned with all ratio measures
because the ratio will tell them what the financial decisions will be. They also consider
that the creditors and stockholders must see good ratios in order to keep the stock price
up to and raise new funds.

e. What is the difference between cross-sectional and time-series ratio analysis? What is
benchmarking?

The cross-sectional and time-series analysis looks at data collected at a single

point in time Then identifies the similarities and differences across companies or to
industry averages. Moreover, benchmarking is a type of cross-sectional analysis where
ratios are compared to those leading competitors in the industry that the company
wanted to compete with. On the other hand, time series- ratio analysis serves as an
evaluation of the firm’s financial performance over time. Both use ratio analysis to
calculate, interpret, and analyze a firm’s financial ratio performance.

f. Why is it preferable to compare ratios calculated using the financial statements that are
dated at the same point in time during the year?

Comparing ratios at the same point in time during the year is the most preferable
so that the comparison will be accurate enough to say if the firm does well or not. It
helps the company to detect weaknesses and room for improvements.

g. Financial ratio analysis is often divided into five areas: liquidity, activity, debt, profitability,
and market ratios. Differentiate each of these areas of analysis from the others. Which is
of the greatest concern to creditors?

Liquidity ratios are indications of the firm’s ability to pay off short-term obligations
as they become due. These include current ratio and quick ratio it focuses on the current
assets and current liabilities. This area of analysis is where creditors are focused,
focusing on the capacity of the firm to pay back the debts that are going to acquire by
the company. Activity ratios are the measurement of how quickly various accounts are
converted into sales or cash. Unlike liquidity ratios, activity ratio tells the efficiency of a
firm operates along with a variety of dimensions such as inventory management,
disbursements, and collections. The debt ratio simply shows how many assets the
company must sell to pay off all its liabilities. The financial analyst is most concerned
with long-term debts because these commit the firm to a stream of contractual payments
over the long run. The more debt a firm has, the greater its risk of being unable to meet
its contractual debt payments. Profitability ratios are used to determine the company's
bottom line for its managers and its return on equity to its investors. Owners, creditors,
and management pay close attention to boosting profits because of the great importance
of the marketplaces on earnings. Market ratios give insight into how investors in the
marketplace feel the firm is doing in terms of risk and return. They tend to reflect, on a
relative basis, the common stockholders’ assessment of all aspects of the firm’s past
and expected future performance

Lesson 4: Basic Financial Analysis

a. Discuss the need for comparative analysis.

By analyzing financial comparatives, companies are able to identify significant trends

and project future trends with the identification of significant or unusual changes. It is needed
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BSBA FM 2-1

to obtain the information required to answer specific questions from the board of
directors and or the investors. Comparisons can be made on an intracompany basis,
Industry averages, and intercompany basis. The intracompany basis is a comparison
within a company to detect changes and significant trends. On the other hand, industry
averages are comparisons that provide other company’s position within the industry.
Unlike, intracompany basis, the intercompany basis is a comparison with other
companies to determine the firm’s competitive position.

b. Identify the tools of financial statement analysis.

There are three tools used to assess the importance of financial data. First is the
horizontal analysis, which evaluates a series of financial statement data over a period of
time. Second is the vertical analysis which evaluates financial statement data by
expressing each item in a financial statement as a percentage of a base amount. Lastly,
ratio analysis expresses the relationship among selected items or financial statement
data.

c. Explain horizontal analysis.

The horizontal analysis also called trend analysis studies the percentage
changes of accounts in comparative financial statements. This analysis emphasizes the
changes in a series of financial statement data over time. This tool is primarily used in an
intra-company comparison.
 
d. Describe vertical analysis.

Vertical Analysis is also called a common size analysis. This studies the
relationship of one single item with all other items in the statement. This analysis is to
express each item as a percent of a base item. This kind of analysis is used in both intra
and inter-company comparisons.

Lesson 5: Risk, Return and Valuation

a. Why is it important for financial managers to understand the valuation process?

Valuation is the process that links risk and returns to determine the worth of an
asset. It is a relatively simple process that can be applied to expected streams of
benefits from bonds, stock, and income properties This process provides a baseline
where it indicates if the track is still right or it needs a little bit of change, it also helps
financial managers to determine ways to improve business. It can also utilize key
performance indicators such as the non-financial aspects of the business. This process
mainly tracks the effectiveness of the financial manager’s strategic decision-making
process.
 
b. What are the three key inputs to the valuation process?

The 3 main inputs in the valuation process are (1) cash flows (returns) It does not
have to have an annual cash flow. It may be given an intermittent or even a single cash
flow for the period., (2) timing is assumed to be at the end of the period/year unless
otherwise stated., and (3) measure of risk the level of risk associated with the cash flows
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BSBA FM 2-1

can significantly affect the values. The greater the risk, the greater the discount factor
should be, vice versa. 

c. What are the key differences between debt and equity?

Debt and equity differ from each other. Debt financing is from creditors who have
a legal right to be repaid while equity financing is from investors who then become part
owners of the firm which only have an expectation of being repaid. With regards to key
differences, there are four characteristics that are considered. First is the voice in
management debtholders do not have voting rights while investors have, considering
that they are already part owners of the firm. Second is the claims on income and
assets, where creditors have the superiority with it, while investors will be paid after all
the creditors have been satisfied. Third is maturity, equity is a permanent form of
financing, unlike debt where maturity is always stated. Last is the tax treatment, where
interest payments to debtholders have interest deductions while dividend payments to
equity owners are not tax-deductible.

d. Explain the linkages among financial decisions, return, risk, and stock valuation.

The company will not run without capital, which is invested by the owners of a
company to run the business. And the main objective of the company is to maximize
these capitals. Therefore, financial decisions are made by the financial managers. These
decisions will be further advised to the board of directors and stockholders what should
be the step that will be done, considering the risk and returns of the decisions. When
considering all alternative financial decisions or possible actions in terms of impact on
the company's share price, financial managers should only accept shares that are
expected to increase the share price. Therefore, there is a mutual relationship between
financial decisions, return, risk, and stock valuation.